Friday, 19 October 2012

Romney's First 100 Days

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The second presidential debate this past Tuesday was quite
contentious and didn’t disappoint. After President Obama got
steamrolled in round one, he took a much more aggressive approach
this time around and it seems to have paid off. At the very
least, he’s slowed the surge of momentum that Romney picked up
since their first debate.

The national polls continue to portray a tight race, but Obama’s
edge has grown slightly in the live betting markets as a 1.8 to 1
favorite.

What’s quite interesting is that, after two presidential debates
and the sole VP debate last week, there has been no discussion of
monetary policy. And with the final debate focusing on
foreign policy this upcoming Monday, we’ll still get nothing on
this issue.

Both candidates have been avoiding any discussion on Fed policy
like the plague lately. You would think that, after the Fed
just announced an unlimited bond buying program a month ago, it
would come up somewhere in the debates.

As an investor, the aggressive actions taken by the Fed weigh
heavily on our market sentiment and the decisions that we make
allocating our capital.

And, of course, the outcome of next month’s election could have a
profound effect on the future course of Fed policy and the
financial markets.

It’s pretty easy to figure out what the ramifications of Fed policy
would be if President Obama wins reelection. Simply put, it
will be business as usual. Fed policy will continue its
ultra-loose accommodative approach with full assurances of its
abilities to conduct monetary policy as it sees fit by the
Executive branch.

In fact, Fed Chairman Bernanke is poised to garner even more
support when the FOMC voting members rotate, starting with the
first meeting in 2013. Richmond Fed President Jeffrey Lacker,
who has been the only official dissenter of Fed policy action, is
out. And he’ll be replaced by one of Bernanke’s staunchest
supporters, Chicago Fed President Charles Evans.

Also, the Fed’s two biggest policy hawks who have been publicly
critical of the direction and efficacy of recent Fed policy actions
won’t have an official vote either. Dallas Fed President
Richard Fisher and Philadelphia Fed President Charles Plosser won’t
be voting members until 2014.

So an Obama victory will let Bernanke and the Fed continue to run
monetary policy loose as a goose for the foreseeable future, and
that should be bullish for risk assets, stocks and commodities,
particularly gold.

But what if we get the other scenario and Romney wins? How
will this affect fed policy, and what will be the reaction from
financial markets?

Well this is what we know. Mitt Romney has made it very clear
that he does not support Chairman Bernanke and the current course
of monetary policy. While the presidential debates have been
reticent on discussing Fed policy, the Republican primaries were
not and Romney was one of the candidates to strongly voice his
opposition to its ongoing strategy to promote a stronger economic
recovery.

He also made critical statements directly after the announcement
that the Fed will begin an unlimited $40 billion per month bond
buying program of mortgage backed debt. The Fed’s balance
sheet will likely top $3 trillion by the time Romney would take
office.

Romney’s First 100 Days

The first 100 days after an inauguration is generally the benchmark
period to measure the early success and effectiveness of a
president -- especially in times of crisis.

When Obama first took office nearly four years ago, he quickly
pushed for a massive stimulus spending bill -- The American
Recovery and Reinvestment Act of 2009 -- that was quickly passed by
the Democratically dominated Legislature.

Romney’s first order of business will likely be managing the state
of the fiscal cliff. How the Congressional landscape pans out
will determine the urgency that Romney will have to deal
with.

Let’s suppose that on Election Day the Republicans maintain control
of the House of Representatives and pick up the net gain of four
seats needed to retake control of the Senate -- a true political
sweep.

With a Romney win and both legislative houses soon to be under
Republican control, the likely scenario is that the lame duck
Congress and outgoing President Obama would pass a bill to prevent
the automatic triggers of the Budget Control Act of 2011 -- aka
“the fiscal cliff” -- to take effect, essentially kicking the can
down the road for the Romney administration and Congress to figure
it out next year.

However, if the Democrats can hold the Senate it could get messy,
and Romney may indeed need to act quickly if no definitive action
is taken before year end and the tax cuts are left to expire and
the sequestration of spending cuts kick in. This would indeed
be an ugly scenario and a low probability outcome.

But what about a “Monetary Cliff”?

Will the first invited visitor to the White House be Ben
Bernanke? Romney has already gone on record that he would
replace the Federal Reserve Chairman.

Bernanke’s appointed term does not expire until January 2014 and,
unless he willingly resigns, he cannot be so easily removed as
stipulated by the Federal Reserve Act. To remove the Fed
Chairman (or any appointed Federal Reserve Governor) against his
wishes would draw in a legal battle that would have to prove
malfeasance or blatant wrongdoing. And despite Romney’s
disapproval, the Chairman cannot simply be removed for his policy
opinions.

But with a Romney win and his outspoken displeasure with Bernanke
Chairing the Fed, I would think that Bernanke would indeed offer
his resignation and step aside, allowing Romney to appoint a new
Chairman. Besides, Bernanke would have less than a year left
and would certainly not get reappointed anyhow.

With a dovish Fed Chairman removed, and a Romney replacement
installed, would we now be facing a “monetary cliff”?

Will the stock market plunge if the FOMC takes away the highly
dependent stimulus that it has been addicted to ever since the
market bottomed in 2009?

Can the market hold key levels of support on its own, without the
“Bernanke” Put that has cradled so many investors with a warm sense
of security and perceived safety from sharp falling
prices?

All of these questions will bring a renewed feeling of uncertainty
to the markets with a Romney win, because all of the current
pledges and forecasts that have been signaled and made transparent
in the committee’s communications could soon be subject to an
abrupt change.

“Are you telling me you won’t promise that interest rates will
remain at ZERO for years anymore”?

If Romney does indeed bring in a new Fed Chairman and signal a
shift in monetary policy, it will have to come very gradually so as
not to spook the markets and send the stimulus addicts into a
frenzied cardiac arrest.

It will also have to come with a counter stimulus measure from the
fiscal side. Perhaps, with dividend and capital gains rates
presumably remaining low under a Romney administration, a tax
holiday offered to corporations could be the perfect remedy.

Currently, US Corporations are sitting on $1.5 trillion in cash,
and roughly 60% of it is overseas.

By allowing a one-time repatriation and dropping the 35% corporate
tax rate on overseas profits substantially, that could allow
billions in cash to funnel back onshore. The funds could be
used to distribute special dividend payouts to shareholders,
initiate stock buyback programs boosting EPS, and encourage
domestic spending and employment hiring.

If Romney wins and pulls the reins back on current Fed policy by
appointing a hawkish replacement, he’ll likely have to fire a
fiscal stimulus bullet to appease financial markets and won’t pile
on more debt to the ballooning deficit.